The research and development tax credit has been a great tax savings incentive to companies looking to increase their internal research and development activities. When President Obama signed the Protecting Americans from Tax Hikes (PATH) Act on December 18, 2015, the research and development (R&D) credit was finally made permanent (retroactively as of January 1, 2015). In addition, the credit now contains two new options for utilization that did not previously exist which broadens the impact of the credit for many small to mid-sized businesses.
Two New Provisions
Previously, the R&D tax credit could only be used to offset regular tax; this rule limited many small to mid-sized businesses in their ability to use the credit if they were subject to the alternative minimum tax (AMT). Beginning in 2016, businesses with less than $50 million in gross receipts will be free to use the credit to offset AMT.
In addition, certain start-up businesses (with less than $5 million in gross receipts) that may not have an income tax liability will be able to offset payroll taxes with the credit to the tune of $250,000. No longer will they have to wait until they generate taxable income to take advantage of the credit savings.
Four Part Test
Businesses should be aware of the four part test that research activities must pass before the corresponding expenditures related to those activities will qualify for the tax credit. The four part test is as follows:
- The R&D activity must be intended to be useful in the development of a new or improved business component for the taxpayer, such as a product, process, technique, formula, invention or software.
- The project must be undertaken for the purpose of discovering information that is technological in nature. Thus, the activity must rely on the principles of physical sciences, such as engineering, biology or computer science.
- The project must be intended to eliminate uncertainty related to the development or improvement of a business component. Uncertainty can include the capability, development method or optimal design of the business component.
- The project must evaluate one or more alternative solutions through the development, refinement and testing of different options. Furthermore, technical risk must be present, which means that there is a chance the project will not be successful.
If you are planning on claiming an R&D tax credit on your business’ next tax return, please consult your tax advisor. Although the benefits of the R&D credit make it attractive, now more than ever, you will want to make certain that you meet the requirements because it has become one of the most heavily audited tax credits by the IRS in recent years.